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Sales and Use Tax Cases You Ought to Know

The Kentucky CPA Journal / Issue 6 2010Tax in the BluegrassDecember 2010

Looking back at Kentucky cases concerning sales and use tax, there are obvious stand outs.  That said, of course, one needs to begin with the sales and use tax statute that applies to the subject matter at issue (for example, the manufacturing-related exemptions), and administrative tax regulations and other administrative guidance (for example, the old Revenue Policies and Circulars, Kentucky Tax Alerts) can be helpful as well.  But, in the absence of administrative guidance and even when administrative guidance exists, the right case can be very useful in addressing the issue at hand. 

Fundamentally, sales and use tax issues can be distilled into two principal questions.  Is this transaction subject to tax?  And, if so, is this transaction exempt from tax? 

Construe Ambiguous Sales and Use Tax Statutes in Taxpayers’ Favor

Say you have an issue regarding whether or not a transaction is subject to sales and use tax.  Then, your issue may involve a determination of the meaning of an ambiguous sales and use tax statute that imposes a tax; in such an instance, George v. Scent, 346 S.W.2d 784 (Ky. 1961), is the go-to case.  That case contains powerful, pro-taxpayer statements such as:

Taxing laws should be plain and precise, for they impose a burden upon the people. That imposition should be explicitly and distinctly revealed. If the Legislature fails so to express its intention and meaning, it is the function of the judiciary to construe the statute strictly and resolve doubts and ambiguities in favor of the taxpayer and against the taxing powers. This is particularly so in the matter of pointing out the subjects to be taxed.  [citations omitted]

The Court in George v. Scent applied the principle expressed above to a question involving the imposition of tax on mobile property brought into Kentucky from another state and held that Kentucky sales and use tax did not apply to that property. 

It is unlikely that you are going to be asked the same question that was before the Court in George v. Scent, but the rule in that case is timeless. 

The Kentucky Sales Tax Is Not Designed to Tax Services

Keeping in mind the basic Kentucky sales and use tax rules that tangible personal property is subject to tax unless otherwise exempt and a service is not subject to tax, it is obvious that this is an outcome determinative distinction.  A key observation inWoodward, Hobson & Fulton, L.L.P. v. Revenue Cabinet, 69 S.W.3d 476 (Ky. App. 2002), drives home this point:

The sales and use tax scheme…is not primarily designed to tax services.

The issue in that case was whether purchases of copies of medical records from out-of-state health care providers was the purchase of: [i] tangible personal property or [ii] a service.  Quite obviously drawing upon the above observation and perhaps implicitly recognizing the principle enumerated in George v. Scent, the Court determined that providing copies in this circumstance was merely incidental to the service rendered and thus, the sales tax did not apply. 

Let’s do a gut check.  Does this make sense?  Does providing a client with a copy of a tax return or an audit report convert a non-taxable service into a sale of tangible personal property?  Sounds pretty solid. 

Sourcing Sales to Kentucky or Not

Another issue related to whether or not a transaction is subject to tax is the determination of the transaction’s situs.  In Revenue Cabinet v. Gruner & Jahr U.S.A. Group, Inc., Civil Action No. 97-CI-00294 (Franklin Cir. Ct. 1998) (commonly known as “Brown Printing”), the issue presented was whether goods sold by a Kentucky retailer and delivered in Kentucky to a common carrier hired by the retailer’s out-of-state customer is a sale subject to tax.  Construing an administrative regulation, the Franklin Circuit Court held that the sale was taxable because it was consummated in Kentucky when the out-of-state customer’s representative, i.e., the common carrier, took possession of the goods in Kentucky.  In this case, the principle enumerated in George v. Scent did not play into the Court’s analysis, perhaps because the Court perceived no ambiguity in the statute.  

Construe Ambiguous Sales and Use Tax Exemptions Against Taxpayers

When the meaning of an ambiguous sales and use tax exemption is in issue, thenPopplewell's Alligator Dock No. 1 v. Revenue Cabinet, 133 S.W.3d 456 (Ky. 2004) is a case that should be referenced.  In comparison to George v. Scent, the Popplewell's Alligator Dock case is much more anti-taxpayer: 

[T]ax exemptions are disfavored and will be narrowly or strictly construed, with all doubts resolved against the exemption’s application, and with the burden placed on the party claiming the exemption to show the party’s entitlement to it.

Note that the rules for tax imposition statutes and those for tax exemptions are polar opposites. 

Where the Occasional Sale Exemption Does Not Apply

When the question presented is whether or not the occasional sale exemption of KRS 139.470(4) applies, it is helpful to look not only at the statutory definition of an “occasional sale” set forth in KRS 139.010(15), but to also look at case law on the topic.  LWD Equipment, Inc. v. Revenue Cabinet, 136 S.W.3d 472 (Ky. 2004), provides a taxpayer’s attempt to take the occasional sale exemption in conjunction with the resale exemption, which would have allowed otherwise non-exempt items to escape taxation altogether.  As the Court observed: 

To adopt the interpretation of the statute proposed by [the taxpayer] would be to exempt completely from taxation items leased. When the items were purchased to be leased, it could be claimed that the transaction was exempt from sales and use tax as a sale for resale….  Then it could be claimed that the lease of the items were exempt as an occasional sale using the theory proposed.  As a result, both of the transactions, the purchase for resale and the lease, would be exempt. Any business operation could simply set up a holding company to avoid all sales and use taxes on its equipment. Certainly, this was not the intention of the General Assembly in enacting sales and use tax laws.

Interestingly, the Court in LWD cited George v. Scent and declared, “Exemptions from taxation must not be presumed or implied, but rather must be clearly stated.”  In this regard, it appears that the Court read the occasional sale exemption as unambiguous with regard to not applying to the transactions at issue in LWD

Unambiguous Sales and Use Tax Exemptions

The application of an unambiguous sales and use tax exemption can cut the other way too - in a taxpayer’s favor.  King Drugs, Inc. v. Revenue Cabinet, 250 S.W.3d 643 (Ky. 2008), is a great case example of that concept. 

Only if the statute is ambiguous, however, or otherwise frustrates a plain reading, do we resort to the canons or rules of construction, such as the rule that tax exemption statutes are to be narrowly construed against the exemption. On the contrary, if a plain reading of the statute yields a reasonable legislative intent, then that reading is decisive and must be given effect regardless of the canons and regardless of our estimate of the statute's wisdom. [citation omitted]

Appling the plain reading of the exemption at issue there, the Court held that it applied to the items at issue so that they were exempt from tax. 

Compare LWD [taxpayer loses] to King Drugs [taxpayer wins].  Notice the difference?  The two cases are like opposite sides of the same coin. 

“It’s In The Way That You Use It….”  Eric Clapton (1986)

In answering the basic questions of whether a transaction is subject to tax (or not) and if so, is it exempt, one should keep in mind the key cases: George v. Scent,Popplewell’s Alligator DockLWD and King Drugs - especially when there is no administrative regulation or other guidance on the topic.  Of course, the answer depends on whether the statute is a taxing statute or an exemption statute and whether that statute is ambiguous, or not. 

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